IRAs: An Even Better Deal for the Long-Term Investor

In 1974, the Individual Retirement Account was introduced as a retirement savings tool. Thirty years later, contribution limits have increased, and there are several types of IRAs available. As the largest tax cut in almost two decade, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made significant changes to the rules governing retirement plans and made the IRA an even more valuable wealth-building tool for savvy investors. IRAs offer investors increasing contribution limits, tax-deferred growth and distribution options.

An IRA can provide a powerful method for potential wealth accumulation regardless of whether it provides an immediate tax benefit. Tax deferral is a powerful ally in building as much money as possible for retirement. It is now more critically important than ever to start a tax-deferred investment program immediately with increasing contribution limits.

During this decade, Americans have witnessed the first increase in IRA contributions in many years. Effective in 2002, the annual limit on IRA contributions increased from $2,000 to $3,000, or $3,500 if you were over age 50. Because of recent legislation, contribution limits will continue to increase until 2008. In 2005 to 2007, the contribution limit will be $4,000 for individuals 49 and younger, and $4,500 in 2005 for Americans age 50 and older. During 2006 and 2007, you will be able to contribute an additional $1,000 if you are age 50 and older. In 2008, the limit will grow to $5,000 with the $1,000 addition if you are age 50 and older.

With limits continuing to grow, establishing an IRA and regularly contributing is smart for the future. Obviously, the larger the sum that is invested and the longer the time horizon, the more significant the amount that can be accrued due to tax-deferred compounding. The principal, or original investment, can earn interest. That interest can earn interest. An IRA can provide a powerful method for potential wealth accumulation regardless of whether it provides an immediate tax benefit.

Two of the most common types of IRAs are the Traditional and the Roth. When choosing which vehicle works for you, consider whether you would like to defer taxes now or later. Traditional IRAs may offer tax deductions now while distributions are taxed upon withdrawals. Annual contributions to a Roth IRA are not tax-deductible, but qualified distributions are tax-free.

The Traditional IRA is an individual retirement savings arrangement funded with deductible and/or nondeductible contributions based on your compensation. Deductibility is dependent on income and participation in an employer-sponsored qualified retirement plan. Once an individual reaches age 70½, contributions cannot be made to an IRA account. This plan is best suited for individuals wishing to save for retirement on a tax-deferred basis or for clients in high tax brackets needing a deduction.

If both the individual and spouse (joint) are not covered by an individual plan, each may take a full deduction of the lesser of $3,000 or 100% of compensation. If either the individual or the spouse is covered by an employer plan, the deductibility* is phased out depending on the individual's filing status, adjusted growth income (AGI) and who is covered.

A Roth IRA is an individual retirement savings arrangement whereby an individual makes nondeductible contributions based on his or her compensation. Annual contributions are not tax-deductible, but qualified distributions are tax-free. Eligible clients are individual filers with an AGI of less than $110,000 (phase-outs between $95,000 and $110,000), joint filers with an AGI level less than $160,000 (phase-outs between $150,000 and $160,000), or married filing separately with an AGI level less than $10,000 (phase-outs between $0 and $10,000). The individual does not have to be younger than age 70½ to make contributions. Even without that up-front tax deduction, however, the Roth IRA is an excellent choice for long-term investing. This is because the IRA provides for tax-deferred growth of all dollars invested.

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